Commission Proposal on CRR III and CRD VI
The European Commission published proposals to amend the CRR and CRD IV at the end of October 2021 to complete the implementation of Basel III into EU law. The new rules are intended to ensure that the EU banking sector becomes more resilient to potential future economic crises. At the same time, the Commission's proposals aim to contribute to Europe’s economic recovery from the COVID 19 pandemic and to the transition to climate neutrality.
1. Measures taken so far
The reforms implemented so far have focused in particular on increasing the quality and quantity of regulatory capital, reducing excessive leverage of banks, increasing the resilience of institutions to short-term liquidity shocks and addressing the too-big-to-fail issue.
As a result of these reforms, for example, the criteria for eligible capital have been tightened, the minimum capital requirements have been increased and new requirements for credit valuation adjustment (“CVA”) risk have been introduced. In addition, a minimum leverage ratio, a liquidity coverage ratio, a net stable funding ratio, large exposure limits and macroprudential capital buffers have been introduced.
From the perspective of the EU legislator, the EU banking sector has become much more resilient to economic crises thanks to these reforms. In addition, from the perspective of the EU legislator, the banking sector has coped with the COVID 19 crisis on a much more stable footing compared to the 2008/2009 financial crisis. Even though the capital adequacy of banks in the EU is satisfactory, some of the problems that came to attention in the wake of the financial crisis have nevertheless not yet been resolved.
2. The Commission’s Proposals
The amendment package presented will complete the implementation of Basel III at EU level. The Commission’s proposals are thus intended to be the final step in the reform of EU banking regulations triggered by Basel III. The proposals of the European Commission include
- a legislative proposal to be known as “CRD VI” to amend the Capital Requirements Directive (Directive 2013/36/EU – “CRD IV”),
- a legislative proposal to amend the Capital Requirements Regulation (Regulation (EU) 2013/575 – “CRR”), to be known as “CRR III”, and
- a separate legislative proposal to amend the Capital Requirements Regulation in the area of resolution (referred to as the “Daisy-Chain” proposal).
3. Overview of the Objectives of the Commission’s Proposals
Against the background of the previous banking supervisory measures, the Commission proposal pursues two fundamental objectives. One is to contribute to financial stability and the other is to contribute to the steady financing of the economy in the context of the economic recovery after the COVID 19 crisis. These general objectives can be subdivided into four more specific objectives:
- Strengthening the risk-based capital framework without significantly increasing overall capital requirements: Completing the reform is necessary to resolve outstanding issues and further strengthen the financial performance of EU-based institutions so that they can better support economic growth and withstand potential future financial crises. The implementation of the outstanding parts of the Basel III reform is also necessary to provide institutions with the necessary regulatory certainty.
- Greater consideration of ESG risks in the regulatory framework: Banks will play a crucial role in financing the transition to a more sustainable economy. At the same time, the transition to a more sustainable economy is likely to create risks for institutions, which they will need to manage appropriately to ensure that risks to financial stability are minimised. This is where prudential regulation should contribute to minimising prudential risks.
- Further harmonisation of supervisory powers and tools: Another area of focus is the proper enforcement of supervisory rules. While Member State legislation ensures a minimum level of harmonisation, supervisory tools and procedures vary significantly across Member States. In addition, it is problematic that third-country branches are only subject to a very low degree of EU-wide harmonised law, which leads on the one hand to considerable opportunities for regulatory arbitrage and on the other hand to a lack of supervision and increased risks for financial stability in the EU. Supervisors often lack the information and powers they need to address the risks. Accordingly, the lack of detailed supervisory reporting and the insufficient exchange of information between authorities responsible for the supervision of different entities/activities of a third country group have so far caused problems in practice. This is to be addressed by the Commission’s proposals.
- Reducing institutions’ administrative costs related to disclosure and improving access to institutions’ supervisory data: The Commission’s proposals are necessary not least to further improve “market discipline”. The current difficulties related to access to supervisory information deprive market participants of the information they need about the prudential situation of institutions, which ultimately reduces the effectiveness of the supervisory framework and raises possible doubts about the resilience of the banking sector, especially during periods of stress. For this reason, the Commission’s proposals aim to centralise the disclosure of supervisory information in order to improve access to supervisory data and comparability within the industry.
4. Selected Aspects of the CRR III Proposal
The most significant changes brought about by the CRR III include rules on the
- the standardised approach for credit risk,
- market risk,
- the credit valuation adjustment (“CVA”),
- operational risk,
- ESG risk and
- disclosure.
Particularly relevant for practice are the proposed changes regarding the Standardised Approach for credit risk. The Standardised Approach is used by most credit institutions in the EU to calculate the capital requirements for their credit risk positions. However, according to the EU legislator, the currently existing Standardised Approach rules prove to be insufficiently risk-sensitive in a number of areas, sometimes leading to an inaccurate or inappropriate measurement of credit risk (either too high or too low) and thus to an inaccurate or inappropriate calculation of own funds requirements.
There are numerous adjustments in the weighting of individual risk positions. This is to affect, for example:
- Risk position vis-à-vis rated institutions: For risk positions with a residual maturity of more than three months, the risk weight of credit quality step 2 is to be reduced from 50% to 30%.
- Risk position vis-à-vis unrated institutions: The risk positions are to be divided into credit quality steps A, B and C, whereby a distinction is to be made between long-term and short-term risk positions within the respective credit quality step. The risk weighting should then range from 20% for a short-term risk position in credit quality step A to 150% for a long-term risk position in credit quality step C.
- Exposure to corporates: The risk weight of credit quality step 3 is to be reduced from 100% to 75%.
- Risk positions in connection with special financing: Within the risk position class “risk positions vis-à-vis corporates”, institutions shall separately disclose risk positions in connection with specialised lending. If a credit assessment by a rating agency (“ECAI”) is available, the risk weights 20%, 50%, 75%, 100% and 150% are to be applied for a credit quality step of 1 to 5.
- Risk positions in connection with land acquisition, development and construction projects: This new risk position should generally be weighted at 150%. Under certain conditions, a weighting of 100% will be sufficient.
- Participation risk positions: Participation risk positions are to be subject to a significantly higher risk weighting in the future. In principle, equity exposures are currently assigned a risk weight of 100%, unless they have to be treated as particularly high-risk exposures according to Art 128 CRR. Only under certain conditions equity risk positions are subject to a risk weighting of 250%. According to the new Art 133 CRR, a risk weight of 250% is generally provided for a participation in a company. If it is a speculative investment (holding period less than three years) or an investment in a venture capital company, a risk weighting of 400% is provided for.
5. Brief Overview of the CRD VI Proposal
CRD VI aims in particular to
- strengthen the independence of supervisory authorities,
- expand the powers of the supervisory authorities and the fit & proper requirements,
- supplement the ESG provisions and to adapt them to the current challenges, and
- to further harmonise the requirements for branches of credit institutions from third countries.
Particularly worth mentioning are the proposed changes in connection with the fit & proper requirements. The reason for the proposed expansion of the fit & proper requirements is, according to the EU legislator, that the framework for fit & proper requirements is one of the least harmonised areas of EU banking supervision law. The aim is to ensure more consistent, efficient and effective supervision of members of the management body and key function holders.
Therefore, in addition to the already existing requirements on professional qualification, further rules on the suitability assessment of members of the management body by the institutions and the competent authorities are to be introduced. Furthermore, minimum requirements for holders of key functions, i.e. persons who have a significant influence on the management of the institution but are not members of the management body, are to be introduced for the first time.
6. Entry into Force
As the Commission proposals are only at the beginning of the European legislative process, the European Commission expects its proposals to enter into force in 2023 at the earliest.